India turns epicentre of emerging markets rout

India became the focal point of an emerging markets (EMs) rout on Monday after months of managing to stay on the periphery. The Indian rupee is the worst performing emerging markets currency, declining 11% year to date against the dollar.

Ripple effects of the depreciating rupee were felt across equities and bond markets as well.

Bloomberg cited an unidentified finance ministry official as saying that India might consider selling deposits denominated in foreign currency to non-resident Indians to shore up the currency. While this statement did help tamp down selling pressure temporarily, no official confirmation was available at the time of going to press.

The immediate trigger for the market meltdown was data released on Friday, which showed India’s current account deficit had widened to 2.4% of gross domestic product (GDP) in the April-June period, on the back of rising crude oil prices, from 1.9% of GDP in the preceding three months. The current account deficit for the April-June period stands at $15.8 billion, the most in five years. To make matters worse, trade deficit widened in July, again due to oil imports, which stoked fears of a further deterioration in the current account deficit.

The rupee ended at 72.45 a dollar, down 0.97% from Friday’s close of 71.74. It opened at 72.11 per dollar. The benchmark 10-year bond yield settled at 8.158%, a level last seen on 25 November 2014, up from its previous close of 8.03%. Bond yields and prices move in opposite directions. In equities, the benchmark 30-stock Sensex fell 1.22%, the sharpest one-day loss in six months.

“There are only five major EM countries running a basic balance deficit and India is one of these. This gap has been weighing on the rupee (down 12% CY18 year to date), and we expect these pressures to sustain in FY19/20,” Tanvee Gupta Jain, an economist at UBS Securities, said in a report. “We revise our FY19 CAD forecast to 2.7% of GDP in FY19 (from 2.5%), much above the sustainable threshold. This would put India’s overall BoP (balance of payments) in a deficit of around 1% of GDP, the first in seven years.”

A 10 September Citibank Wealth Management report said it saw a further weakening of emerging market currencies over the next 12 months. Another report from ING expected the rupee-dollar to trade in the 74-75 area over the next six months.

The report also said that growth could potentially slow as the current market uncertainty filters through to economic activity.

Moody’s Investors Service, in a report released on Monday, said a sustained weakening of the rupee would be credit negative for its rated Indian companies, particularly those that generate revenue in rupees but rely on dollar debt to fund their operations and have significant dollar-based costs, including capital expenses.

A fall in the home currency against the dollar came amid fears of a potential escalation in the China-US trade conflict after President Donald Trump said he was ready to impose tariffs on an additional $267 billion of Chinese goods, on top of a proposed $200 billion. Another factor was the stronger-than-expected August US jobs report, which boosted the dollar, keeping the Federal Reserve on track to lift interest rates this month and making another hike in December more likely.

Foreign investors have sold $424.8 million in equities and $6.25 billion in India debt so far this year.

The Reserve Bank of India (RBI) sold $6.18 billion of foreign currency in June and $5.8 billion in May to protect the rupee, shows central bank data.

“Rupee closing of 72.45 to the dollar is not a comforting situation for market participants. The statement from the finance ministry official that they are looking at NRI (non-resident Indian) bonds is a comforting move for dollar-rupee and liquidity,” said Paresh Nayar, the Mumbai-based head of currency and money markets at FirstRand.

With the sharp depreciation in the rupee and intervention by RBI in the forex market, the possibility of a rate hike has also increased.

The central bank had earlier hiked key policy rates by 25 basis points each at its June and August bimonthly review to 6.5%.

“Recent INR depreciation poses risks to our monetary policy view of a long pause. However, we do not expect sharp monetary tightening to combat the currency move. In similar periods of INR weakness, such as Q3 13, we believe aggressive tightening was ineffective, if not counterproductive, in combating the INR’s fall,” said Siddhartha Sanyal, chief India economist, Barclays, in a report.

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